India rate cut clamour misses rupee’s fall-JPM

Indian markets are rallying this week as they price in an interest rate cut at the Reserve Bank’s June 18 meeting. With the country still in shock after last week’s 5.3 percent first quarter GDP growth print, it is easy to understand the clamour for rate cuts. After all, first quarter growth just a year ago was 9.2 percent.

Yet, there may be little the RBI can do to kickstart growth and investment. Many would argue the growth slowdown is not caused by tight monetary conditions but is down to supply constraints and macroeconomic risks –the government’s inability to lift a raft of crippling subsidies has swollen the fiscal deficit to almost 6 percent while inhibitions on foreign investment in food processing and retail keep food prices volatile.

The other side of the problem is of course the rupee which has plunged to record lows amid the global turmoil. Lower interest rates could leave the currency vulnerable to further losses.

It is the currency factor that should rule out rate cuts at this points, economists at JP Morgan write. They calculate that the rupee’s 12 percent plunge since March against the dollar translates into 100 basis points worth of monetary easing.

With India’s export-import sector now accounting for almost 60 percent of GDP now (up from less than 30 percent in 2000 ) that has already resulted in new export orders and an easing of non-oil imports, the bank notes.

Based on an analysis of the monetary conditions index (MCI) JPM economists conclude in fact that Indian monetary conditions have eased to well below their 2002-2007 average, possibly accounting for the pickup in headline inflation over the past two months. (The MCI is calculated by taking the weighted average of changes in short-term interest rates and the exchange rate over a period). The economists write:

Monetary conditions have eased dramatically over the last three months, are at their lowest level in 20 months, and the sharp depreciation of the currency is equivalent to a 100 bps reduction in market rates since March. This needs to be taken into account for those who believe more monetary easing is warranted.

Even if the RBI cuts interest rates, Indian growth will not accelerate any time soon, JPM argues, citing the macro and regulatory uncertainty:

Policymakers may be well served to focus on these areas rather than undertake substantial monetary easing in light of the events of the last three months.